WEBVTT 00:00:00.000 --> 00:00:01.482 align:middle line:90% [SQUEAKING] 00:00:01.482 --> 00:00:02.964 align:middle line:90% [RUSTLING] 00:00:02.964 --> 00:00:04.446 align:middle line:90% [CLICKING] 00:00:04.446 --> 00:00:16.309 align:middle line:90% 00:00:16.309 --> 00:00:18.770 align:middle line:84% RICARDO CABALLERO: OK, so today we're 00:00:18.770 --> 00:00:20.740 align:middle line:84% going to start talking about the long run. 00:00:20.740 --> 00:00:22.970 align:middle line:84% I've been talking about the business cycles, 00:00:22.970 --> 00:00:25.095 align:middle line:84% and today we're going to start talking about things 00:00:25.095 --> 00:00:27.410 align:middle line:90% that happen over decades. 00:00:27.410 --> 00:00:32.420 align:middle line:84% But before I do that, before we finish with the short run, 00:00:32.420 --> 00:00:37.130 align:middle line:84% medium run, I don't want to give you the impression 00:00:37.130 --> 00:00:42.110 align:middle line:84% that once you understand the IS-LM-PC 00:00:42.110 --> 00:00:48.110 align:middle line:84% you can start managing monetary policy immediately. 00:00:48.110 --> 00:00:51.290 align:middle line:84% There is a lot of noise of all sorts of complexity 00:00:51.290 --> 00:00:53.240 align:middle line:84% in the real world, of course, that 00:00:53.240 --> 00:01:01.460 align:middle line:84% can make policies very hard to manage in practice. 00:01:01.460 --> 00:01:03.200 align:middle line:90% Macroeconomic policies. 00:01:03.200 --> 00:01:05.870 align:middle line:84% And one fundamental principle, I would say, 00:01:05.870 --> 00:01:10.790 align:middle line:84% is that policymakers understand that speed can kill, 00:01:10.790 --> 00:01:15.760 align:middle line:84% and that's very obvious during financial crisis. 00:01:15.760 --> 00:01:21.540 align:middle line:84% There we all understand that the response needs to be large. 00:01:21.540 --> 00:01:24.540 align:middle line:84% It has to be a response with overwhelming force. 00:01:24.540 --> 00:01:26.280 align:middle line:84% Essentially, because things are happening 00:01:26.280 --> 00:01:28.560 align:middle line:84% so fast that very few corporations, even 00:01:28.560 --> 00:01:31.620 align:middle line:84% healthy corporations that can adjust quickly 00:01:31.620 --> 00:01:34.620 align:middle line:84% enough to the pace at which things are changing, 00:01:34.620 --> 00:01:39.040 align:middle line:84% prices become non-informative, fire sales take place, 00:01:39.040 --> 00:01:40.920 align:middle line:84% and obviously it's very difficult 00:01:40.920 --> 00:01:43.930 align:middle line:84% to make economic decisions in that context. 00:01:43.930 --> 00:01:47.425 align:middle line:84% And so that's the reason they are-- the speed on the policy 00:01:47.425 --> 00:01:49.300 align:middle line:84% direction goes very clearly in one direction. 00:01:49.300 --> 00:01:51.750 align:middle line:90% Do it quickly and very large. 00:01:51.750 --> 00:01:56.440 align:middle line:84% Now, on the other hand, when you're 00:01:56.440 --> 00:01:58.930 align:middle line:84% going through a period in which you're hiking interest 00:01:58.930 --> 00:02:04.690 align:middle line:84% rates, for example, like we're going through now, 00:02:04.690 --> 00:02:07.420 align:middle line:84% the tendency is towards gradualism, 00:02:07.420 --> 00:02:11.020 align:middle line:84% to do it very slowly, because something can break along 00:02:11.020 --> 00:02:11.800 align:middle line:90% the path. 00:02:11.800 --> 00:02:17.080 align:middle line:84% And it's often the case that for sufficiently large adjustments, 00:02:17.080 --> 00:02:18.490 align:middle line:90% something breaks. 00:02:18.490 --> 00:02:23.890 align:middle line:84% And so here you have an example of major episode of hiking 00:02:23.890 --> 00:02:26.020 align:middle line:84% in the US and things that have happened 00:02:26.020 --> 00:02:30.310 align:middle line:90% among those major episodes. 00:02:30.310 --> 00:02:34.390 align:middle line:84% This one actually, I have a personal attachment to that one, 00:02:34.390 --> 00:02:37.960 align:middle line:84% because I was studying in Chile around then. 00:02:37.960 --> 00:02:39.770 align:middle line:84% Everything was going wonderfully. 00:02:39.770 --> 00:02:41.480 align:middle line:84% Massive capital flows through Chile. 00:02:41.480 --> 00:02:43.580 align:middle line:84% Emerging markets were very popular. 00:02:43.580 --> 00:02:46.480 align:middle line:84% We all felt very wealthy, rich, and so on. 00:02:46.480 --> 00:02:50.260 align:middle line:84% And right after I finished college, 00:02:50.260 --> 00:02:51.980 align:middle line:84% I was not planning to come to the US. 00:02:51.980 --> 00:02:52.480 align:middle line:90% Why? 00:02:52.480 --> 00:02:54.980 align:middle line:84% Things were going very well in Chile. 00:02:54.980 --> 00:02:57.050 align:middle line:84% But the US decided to hike interest rates 00:02:57.050 --> 00:02:58.290 align:middle line:90% very aggressively. 00:02:58.290 --> 00:03:01.320 align:middle line:84% All of a sudden, capital flows to emerging markets disappeared. 00:03:01.320 --> 00:03:03.980 align:middle line:84% We went into an enormous financial crisis. 00:03:03.980 --> 00:03:06.240 align:middle line:84% I lost-- I had no opportunity cost, 00:03:06.240 --> 00:03:08.810 align:middle line:84% and I had to come to study to the US. 00:03:08.810 --> 00:03:12.920 align:middle line:84% So I know that aggressive hikes can matter, 00:03:12.920 --> 00:03:14.990 align:middle line:90% can make differences to people. 00:03:14.990 --> 00:03:19.820 align:middle line:84% And there is a decade that followed that episode that 00:03:19.820 --> 00:03:22.650 align:middle line:84% is called the lost decade of Latin America, essentially. 00:03:22.650 --> 00:03:24.680 align:middle line:90% So things did break. 00:03:24.680 --> 00:03:26.930 align:middle line:84% And one of the main reasons they did 00:03:26.930 --> 00:03:29.745 align:middle line:84% break is because at the time, most of the capital 00:03:29.745 --> 00:03:31.370 align:middle line:84% flows-- that's not what happens today-- 00:03:31.370 --> 00:03:34.520 align:middle line:84% were really being managed by global banks. 00:03:34.520 --> 00:03:37.730 align:middle line:84% And banks can get very distressed 00:03:37.730 --> 00:03:41.250 align:middle line:84% when interest rates rise very quickly. 00:03:41.250 --> 00:03:44.870 align:middle line:84% And so that was essentially a problem with the US 00:03:44.870 --> 00:03:48.470 align:middle line:84% banks, the major global banks, but the US banks in particular 00:03:48.470 --> 00:03:52.560 align:middle line:84% that triggered an emerging market crisis. 00:03:52.560 --> 00:03:55.892 align:middle line:84% This one also had huge consequences, actually. 00:03:55.892 --> 00:03:57.600 align:middle line:84% And it's interesting because this episode 00:03:57.600 --> 00:04:04.590 align:middle line:84% is similar to what is going on right now 00:04:04.590 --> 00:04:07.300 align:middle line:90% or what may happen soon. 00:04:07.300 --> 00:04:10.710 align:middle line:84% So this episode of hikes that ended what 00:04:10.710 --> 00:04:13.870 align:middle line:84% is called the savings and loan crisis. 00:04:13.870 --> 00:04:16.529 align:middle line:84% And those, the best parallel to today, 00:04:16.529 --> 00:04:19.120 align:middle line:84% are the small regional banks, if you will. 00:04:19.120 --> 00:04:22.530 align:middle line:84% And they weren't able to withstand this sharp rise 00:04:22.530 --> 00:04:25.710 align:middle line:84% in interest rate, which is very much what is going on right now 00:04:25.710 --> 00:04:26.880 align:middle line:90% in the US. 00:04:26.880 --> 00:04:30.990 align:middle line:84% This one actually ended up with also another problem, which 00:04:30.990 --> 00:04:34.590 align:middle line:90% is the bubble burst in Japan. 00:04:34.590 --> 00:04:36.670 align:middle line:90% Episode of hiking in the US. 00:04:36.670 --> 00:04:40.660 align:middle line:84% And there we had a major crisis in Japan. 00:04:40.660 --> 00:04:43.980 align:middle line:84% The price of real estate collapsed, 00:04:43.980 --> 00:04:46.860 align:middle line:84% and essentially they, since then, they 00:04:46.860 --> 00:04:49.380 align:middle line:84% have never been able to grow as they used to 00:04:49.380 --> 00:04:52.470 align:middle line:90% before that episode. 00:04:52.470 --> 00:04:55.380 align:middle line:84% That's called sometimes the tequila crisis. 00:04:55.380 --> 00:04:59.940 align:middle line:84% This is a Mexican bond crisis, and it was, again, the result 00:04:59.940 --> 00:05:02.050 align:middle line:90% of a hiking episode in the US. 00:05:02.050 --> 00:05:05.190 align:middle line:84% Conditions tightened to emerging markets. 00:05:05.190 --> 00:05:10.110 align:middle line:84% Their bond market essentially exploded. 00:05:10.110 --> 00:05:13.420 align:middle line:84% This is a global financial crisis, the Great Recession. 00:05:13.420 --> 00:05:18.960 align:middle line:84% It was again preceded by episode of aggressive hikes, which 00:05:18.960 --> 00:05:25.660 align:middle line:84% eventually let to turn around as house prices were rising 00:05:25.660 --> 00:05:28.540 align:middle line:84% steadily throughout the episode and a lot of financial assets 00:05:28.540 --> 00:05:32.570 align:middle line:84% were created around that housing wealth that was being created. 00:05:32.570 --> 00:05:35.200 align:middle line:84% That hike in interest rate eventually put a stop, an end 00:05:35.200 --> 00:05:37.840 align:middle line:84% to that appreciation of house prices. 00:05:37.840 --> 00:05:39.550 align:middle line:84% In fact, they turned around, and it 00:05:39.550 --> 00:05:43.630 align:middle line:84% led to a very significant financial crisis. 00:05:43.630 --> 00:05:45.890 align:middle line:84% And this is where we're at right now. 00:05:45.890 --> 00:05:50.270 align:middle line:84% And so we are already seeing some tremors and so on. 00:05:50.270 --> 00:05:53.920 align:middle line:84% So the point is when sometimes people say, well, 00:05:53.920 --> 00:05:56.080 align:middle line:84% why isn't the fed more aggressive 00:05:56.080 --> 00:05:58.520 align:middle line:84% if we have high inflation and go very quickly at it? 00:05:58.520 --> 00:06:01.630 align:middle line:84% Well, it's because things can go wrong. 00:06:01.630 --> 00:06:05.480 align:middle line:84% And it typically happens that things do go wrong. 00:06:05.480 --> 00:06:07.360 align:middle line:84% You don't know exactly what will blow up, 00:06:07.360 --> 00:06:09.700 align:middle line:90% but something may blow up. 00:06:09.700 --> 00:06:12.880 align:middle line:84% And typically it's associated to some financial market that 00:06:12.880 --> 00:06:14.995 align:middle line:84% is very hot, and the market and the banks 00:06:14.995 --> 00:06:16.870 align:middle line:84% are always involved in that because the banks 00:06:16.870 --> 00:06:19.180 align:middle line:90% are very lever. 00:06:19.180 --> 00:06:21.190 align:middle line:84% They have little capital relative to the assets 00:06:21.190 --> 00:06:23.870 align:middle line:84% they have, and that means a small variation 00:06:23.870 --> 00:06:27.320 align:middle line:84% in the price of assets can lead to very large changes 00:06:27.320 --> 00:06:29.480 align:middle line:90% in the value of their capital. 00:06:29.480 --> 00:06:30.210 align:middle line:90% Anyways. 00:06:30.210 --> 00:06:31.740 align:middle line:90% So just a warning. 00:06:31.740 --> 00:06:36.630 align:middle line:84% So if you get a job at the fed, please be careful. 00:06:36.630 --> 00:06:38.880 align:middle line:90% OK, now let me switch gears. 00:06:38.880 --> 00:06:42.360 align:middle line:84% We're going to talk about something 00:06:42.360 --> 00:06:45.100 align:middle line:84% a little different from what we have been discussing up to now. 00:06:45.100 --> 00:06:49.500 align:middle line:84% So this is growth projections for different regions 00:06:49.500 --> 00:06:51.600 align:middle line:90% in the world. 00:06:51.600 --> 00:06:54.815 align:middle line:84% This is something that is published by the IMF. 00:06:54.815 --> 00:06:56.440 align:middle line:84% It's called the World Economic Outlook. 00:06:56.440 --> 00:06:57.990 align:middle line:90% I think I mentioned it before. 00:06:57.990 --> 00:06:59.790 align:middle line:84% And here you have some forecasts. 00:06:59.790 --> 00:07:01.900 align:middle line:84% Well, this is actually what happened. 00:07:01.900 --> 00:07:07.650 align:middle line:84% So growth in the global economy was about 3.4% 2022. 00:07:07.650 --> 00:07:11.910 align:middle line:84% Advanced economies grew at 2.7%, emerging markets and developing 00:07:11.910 --> 00:07:14.460 align:middle line:90% economies at 3.9%. 00:07:14.460 --> 00:07:15.910 align:middle line:90% And then you see forecasts. 00:07:15.910 --> 00:07:23.190 align:middle line:84% And the further out you go is less related 00:07:23.190 --> 00:07:24.450 align:middle line:90% to the current cycle. 00:07:24.450 --> 00:07:26.640 align:middle line:84% It's more related to what is structural. 00:07:26.640 --> 00:07:30.600 align:middle line:84% The structural growth of the different parts of the world. 00:07:30.600 --> 00:07:34.170 align:middle line:84% And you see that for 2024, the global economy 00:07:34.170 --> 00:07:37.450 align:middle line:84% is projected, expected to grow at around 3.1%. 00:07:37.450 --> 00:07:39.790 align:middle line:84% These forecasts were made before financial mess that 00:07:39.790 --> 00:07:42.730 align:middle line:84% were going on right now, so probably the next World Economic 00:07:42.730 --> 00:07:47.800 align:middle line:84% Outlook will have, at least for 2023, will downgrade the growth. 00:07:47.800 --> 00:07:50.980 align:middle line:84% Probably not for 2024, but yes, for 2023 00:07:50.980 --> 00:07:53.440 align:middle line:84% Anyways, advanced economies expected 00:07:53.440 --> 00:07:58.520 align:middle line:84% to grow at 1.4%, emerging markets at 4.2%. 00:07:58.520 --> 00:08:03.630 align:middle line:84% So these forecasts are based on a combination 00:08:03.630 --> 00:08:05.760 align:middle line:84% of cyclical factors, fluctuations 00:08:05.760 --> 00:08:08.100 align:middle line:84% of the short run, medium run, the kind of things we 00:08:08.100 --> 00:08:09.730 align:middle line:90% have been discussing up to now. 00:08:09.730 --> 00:08:12.000 align:middle line:84% Some economists will have to go through recessions. 00:08:12.000 --> 00:08:13.680 align:middle line:84% Some economists are going through booms. 00:08:13.680 --> 00:08:17.530 align:middle line:84% That probably dominates the forecast on 2023. 00:08:17.530 --> 00:08:20.550 align:middle line:84% But as I said before, the further out you go, 00:08:20.550 --> 00:08:22.830 align:middle line:84% the less relevant is the current business cycle 00:08:22.830 --> 00:08:25.620 align:middle line:84% and the more relevant is the structural trend 00:08:25.620 --> 00:08:27.870 align:middle line:84% of the different regions of the world. 00:08:27.870 --> 00:08:31.140 align:middle line:84% So I would conjecture that in this, when they formulated 00:08:31.140 --> 00:08:35.280 align:middle line:84% this forecast, this is very much based on more longer-run growth 00:08:35.280 --> 00:08:38.159 align:middle line:84% model, the kind of models we are going to discuss now. 00:08:38.159 --> 00:08:41.760 align:middle line:84% While this is probably totally dominated by the kind of things 00:08:41.760 --> 00:08:43.099 align:middle line:90% we discuss up to now. 00:08:43.099 --> 00:08:47.040 align:middle line:90% 00:08:47.040 --> 00:08:50.910 align:middle line:84% There are several things that are interesting here, 00:08:50.910 --> 00:08:55.870 align:middle line:84% aside from the fluctuations in year to year. 00:08:55.870 --> 00:08:57.360 align:middle line:84% One thing you can see, for example, 00:08:57.360 --> 00:09:01.200 align:middle line:84% is that regardless of year, on average, 00:09:01.200 --> 00:09:03.060 align:middle line:84% emerging markets tend to grow faster 00:09:03.060 --> 00:09:05.330 align:middle line:84% than developed economies, advanced economies. 00:09:05.330 --> 00:09:07.080 align:middle line:84% So one of the things we want to understand 00:09:07.080 --> 00:09:09.950 align:middle line:90% is why is that the case. 00:09:09.950 --> 00:09:12.560 align:middle line:90% But it's very clear here. 00:09:12.560 --> 00:09:14.450 align:middle line:84% The first model we're going to look at, 00:09:14.450 --> 00:09:16.250 align:middle line:84% which probably will happen on Wednesday, 00:09:16.250 --> 00:09:18.440 align:middle line:84% will try to explain essentially that-- why 00:09:18.440 --> 00:09:22.190 align:middle line:84% is it that these guys tend to grow faster than the advanced 00:09:22.190 --> 00:09:23.120 align:middle line:90% economies? 00:09:23.120 --> 00:09:26.242 align:middle line:90% 00:09:26.242 --> 00:09:28.550 align:middle line:90% So growth is important. 00:09:28.550 --> 00:09:31.880 align:middle line:84% Understanding economic growth is hugely important for the world, 00:09:31.880 --> 00:09:35.310 align:middle line:84% for understanding the health of an economy. 00:09:35.310 --> 00:09:39.710 align:middle line:84% Here you see-- this comes from the textbook-- 00:09:39.710 --> 00:09:50.040 align:middle line:84% the US GDP in 2012 dollars from 1890 to 2017, I think 00:09:50.040 --> 00:09:52.700 align:middle line:90% is this one, the end year. 00:09:52.700 --> 00:09:54.620 align:middle line:84% The important thing to notice here 00:09:54.620 --> 00:10:00.920 align:middle line:84% is how large is the change in GDP in during this period. 00:10:00.920 --> 00:10:05.960 align:middle line:84% GDP here, measured in the same prices, so 2012 prices, 00:10:05.960 --> 00:10:09.290 align:middle line:90% is 50 times that in 1890. 00:10:09.290 --> 00:10:10.430 align:middle line:90% That's a big thing. 00:10:10.430 --> 00:10:12.530 align:middle line:84% When we talk about business cycle fluctuations, 00:10:12.530 --> 00:10:15.530 align:middle line:84% we're talking about, in an economy like the US, 00:10:15.530 --> 00:10:19.280 align:middle line:90% 2%, 2.5%, 3% up and down. 00:10:19.280 --> 00:10:20.970 align:middle line:90% This is 50 times. 00:10:20.970 --> 00:10:25.070 align:middle line:84% So over longer periods of time, you can almost 00:10:25.070 --> 00:10:26.750 align:middle line:84% ignore the business cycle, and it's 00:10:26.750 --> 00:10:30.380 align:middle line:90% all about that long-run trend. 00:10:30.380 --> 00:10:32.370 align:middle line:90% Here, what is this episode? 00:10:32.370 --> 00:10:35.983 align:middle line:84% So here, if you look at this picture, 00:10:35.983 --> 00:10:37.400 align:middle line:84% especially the further out you are 00:10:37.400 --> 00:10:42.080 align:middle line:84% on the room, what dominates here is clearly the trend. 00:10:42.080 --> 00:10:44.810 align:middle line:84% The only action you see, really significant action 00:10:44.810 --> 00:10:47.240 align:middle line:84% different from the trend, is around here. 00:10:47.240 --> 00:10:48.220 align:middle line:90% What happened there? 00:10:48.220 --> 00:10:51.340 align:middle line:90% 00:10:51.340 --> 00:10:52.760 align:middle line:90% It's the Great Depression. 00:10:52.760 --> 00:10:56.500 align:middle line:84% So even the Great Depression doesn't look that big relative 00:10:56.500 --> 00:10:58.530 align:middle line:90% to what the trend can do. 00:10:58.530 --> 00:11:00.880 align:middle line:84% So of course, it's very difficult 00:11:00.880 --> 00:11:02.440 align:middle line:84% to affect the trend of a country, 00:11:02.440 --> 00:11:05.620 align:middle line:84% but the trend makes a huge difference for the welfare, 00:11:05.620 --> 00:11:11.910 align:middle line:84% for the economic well-being of a country. 00:11:11.910 --> 00:11:13.350 align:middle line:90% Good. 00:11:13.350 --> 00:11:18.120 align:middle line:84% Now, a lot of that is because also the US population 00:11:18.120 --> 00:11:22.600 align:middle line:84% grew up and grew a lot during this episode. 00:11:22.600 --> 00:11:26.900 align:middle line:84% So often when you look at long-run trends, 00:11:26.900 --> 00:11:29.120 align:middle line:84% rather than looking at the level of GDP, 00:11:29.120 --> 00:11:33.530 align:middle line:84% you tend to look at the level of GDP per person, per capita, 00:11:33.530 --> 00:11:34.500 align:middle line:90% or something like that. 00:11:34.500 --> 00:11:38.480 align:middle line:84% And that picture is exactly the same picture as the previous one 00:11:38.480 --> 00:11:41.975 align:middle line:84% but divided by population at each point in time. 00:11:41.975 --> 00:11:43.610 align:middle line:90% OK. 00:11:43.610 --> 00:11:45.790 align:middle line:84% And that's an important-- over long periods-- 00:11:45.790 --> 00:11:47.510 align:middle line:84% at the business cycle frequency, you 00:11:47.510 --> 00:11:50.248 align:middle line:84% can almost ignore changes in population-- no, changes 00:11:50.248 --> 00:11:52.040 align:middle line:84% in population you can not ignore completely 00:11:52.040 --> 00:11:53.380 align:middle line:90% unless you are in a war. 00:11:53.380 --> 00:11:56.540 align:middle line:84% You worry about other things-- labor force participation 00:11:56.540 --> 00:11:57.630 align:middle line:90% and stuff like that. 00:11:57.630 --> 00:12:00.320 align:middle line:84% But population is irrelevant to the business cycle. 00:12:00.320 --> 00:12:02.960 align:middle line:84% Growth is relevant to the business cycle frequency, 00:12:02.960 --> 00:12:05.520 align:middle line:84% but not over long periods of time. 00:12:05.520 --> 00:12:08.150 align:middle line:84% In this period here, population in the US 00:12:08.150 --> 00:12:11.150 align:middle line:84% increased from 63 million to 320 million. 00:12:11.150 --> 00:12:13.340 align:middle line:84% So that's a lot more workers in principle 00:12:13.340 --> 00:12:16.020 align:middle line:90% that you have for that economy. 00:12:16.020 --> 00:12:20.840 align:middle line:84% So a lot of that trend is explained by population growth, 00:12:20.840 --> 00:12:22.350 align:middle line:90% and that's one of the reasons-- 00:12:22.350 --> 00:12:24.560 align:middle line:90% sorry. 00:12:24.560 --> 00:12:26.330 align:middle line:84% A lot of the strength in this picture 00:12:26.330 --> 00:12:29.390 align:middle line:84% here is explained by population growth. 00:12:29.390 --> 00:12:31.550 align:middle line:84% That's one of the reasons we're in a tricky time 00:12:31.550 --> 00:12:33.230 align:middle line:84% in the global economy, because there 00:12:33.230 --> 00:12:35.570 align:middle line:84% are many important regions of the world where population 00:12:35.570 --> 00:12:36.900 align:middle line:90% is no longer growing. 00:12:36.900 --> 00:12:40.670 align:middle line:84% So we got used to a period in which population growth was very 00:12:40.670 --> 00:12:44.960 align:middle line:84% steady and high, and now, many parts of the world, 00:12:44.960 --> 00:12:47.900 align:middle line:84% important parts of the world, have negative population 00:12:47.900 --> 00:12:49.250 align:middle line:90% growth-- 00:12:49.250 --> 00:12:55.280 align:middle line:84% Japan, Korea, China, most of continental Europe, 00:12:55.280 --> 00:12:57.420 align:middle line:84% even places in Latin America, and so on. 00:12:57.420 --> 00:13:00.860 align:middle line:84% So this is a big change for the world. 00:13:00.860 --> 00:13:03.200 align:middle line:84% But anyways, during that period there 00:13:03.200 --> 00:13:04.950 align:middle line:90% was a lot of population growth. 00:13:04.950 --> 00:13:07.010 align:middle line:84% And the US in particular, again, as I 00:13:07.010 --> 00:13:09.510 align:middle line:84% said before, from 63 to 320 million. 00:13:09.510 --> 00:13:12.350 align:middle line:84% So if you really want to measure welfare 00:13:12.350 --> 00:13:19.130 align:middle line:84% of the economy, the well-being of individuals in the US, 00:13:19.130 --> 00:13:20.630 align:middle line:84% the previous picture is misleading 00:13:20.630 --> 00:13:25.160 align:middle line:84% because you have to-- yeah, the final pie is 50 times larger 00:13:25.160 --> 00:13:27.500 align:middle line:84% than the first, than the beginning pie, 00:13:27.500 --> 00:13:30.470 align:middle line:84% but you have 320 million people to split it 00:13:30.470 --> 00:13:32.970 align:middle line:90% among as opposed to 63 million. 00:13:32.970 --> 00:13:35.030 align:middle line:90% So this picture captures that. 00:13:35.030 --> 00:13:36.800 align:middle line:84% A statistic that is often described 00:13:36.800 --> 00:13:42.620 align:middle line:84% when you talk about long-run growth is GDP per person. 00:13:42.620 --> 00:13:45.110 align:middle line:84% And you still see that what dominates 00:13:45.110 --> 00:13:51.080 align:middle line:84% this picture is a trend, but the difference between this GDP 00:13:51.080 --> 00:13:53.450 align:middle line:84% per person in the US at the end of the sample 00:13:53.450 --> 00:13:55.670 align:middle line:84% versus the beginning of the sample, it's 10 to 1, 00:13:55.670 --> 00:13:59.210 align:middle line:84% not 50 to 1, so it makes a difference, population. 00:13:59.210 --> 00:14:00.310 align:middle line:90% It's still big. 00:14:00.310 --> 00:14:02.500 align:middle line:84% It's still what dominates this picture is that. 00:14:02.500 --> 00:14:04.530 align:middle line:84% Of course the Great Recession looks bigger 00:14:04.530 --> 00:14:08.600 align:middle line:84% now because you're comparing it with a number that 00:14:08.600 --> 00:14:11.990 align:middle line:84% grows by a factor of 10, not by a factor of 50, 00:14:11.990 --> 00:14:13.940 align:middle line:90% so it looks bigger naturally. 00:14:13.940 --> 00:14:16.610 align:middle line:84% The same 30% decline in output is a lot bigger 00:14:16.610 --> 00:14:20.720 align:middle line:84% when you're comparing it with a factor of 10 00:14:20.720 --> 00:14:22.970 align:middle line:84% than when you compare it with a factor of 50. 00:14:22.970 --> 00:14:25.890 align:middle line:90% But still, it looks bigger. 00:14:25.890 --> 00:14:30.080 align:middle line:84% But the picture is dominated by the trend. 00:14:30.080 --> 00:14:33.640 align:middle line:84% So all this to say that what we're going to study now 00:14:33.640 --> 00:14:34.710 align:middle line:90% is very important. 00:14:34.710 --> 00:14:36.880 align:middle line:84% It's not what dominates the day to day news 00:14:36.880 --> 00:14:39.080 align:middle line:84% because it happens slowly and over time, 00:14:39.080 --> 00:14:40.700 align:middle line:90% but it is very important. 00:14:40.700 --> 00:14:44.310 align:middle line:90% 00:14:44.310 --> 00:14:47.010 align:middle line:84% So how do we measure these things? 00:14:47.010 --> 00:14:49.110 align:middle line:84% When you're looking within a country, 00:14:49.110 --> 00:14:53.820 align:middle line:84% you do reasonably well, not perfect, but reasonably well, 00:14:53.820 --> 00:14:55.890 align:middle line:84% and perhaps not over periods as long as the one 00:14:55.890 --> 00:14:58.750 align:middle line:84% I showed you, by looking at GDP per capita. 00:14:58.750 --> 00:15:01.170 align:middle line:90% That's fine. 00:15:01.170 --> 00:15:04.620 align:middle line:84% You measure it real GDP per capita, that's about fine. 00:15:04.620 --> 00:15:07.600 align:middle line:84% But when you compare across different regions of the world 00:15:07.600 --> 00:15:10.780 align:middle line:84% and so on, those comparisons is very misleading. 00:15:10.780 --> 00:15:15.460 align:middle line:90% So to say that the US has-- 00:15:15.460 --> 00:15:18.720 align:middle line:90% I don't know. 00:15:18.720 --> 00:15:21.978 align:middle line:84% What is the US GDP per capita today in the US? 00:15:21.978 --> 00:15:23.020 align:middle line:90% Somebody should check it. 00:15:23.020 --> 00:15:28.170 align:middle line:84% But it's about maybe $70,000, something like that. 00:15:28.170 --> 00:15:29.460 align:middle line:90% I don't know. 00:15:29.460 --> 00:15:35.250 align:middle line:84% And then you see another country that has, say, Italy, 00:15:35.250 --> 00:15:38.290 align:middle line:90% $50,000 per capita. 00:15:38.290 --> 00:15:41.800 align:middle line:84% That comparison is not that meaningful. 00:15:41.800 --> 00:15:43.930 align:middle line:84% It's indicative of something, but it's not 00:15:43.930 --> 00:15:45.020 align:middle line:90% completely meaningful. 00:15:45.020 --> 00:15:46.770 align:middle line:84% And I'm going to show you an example which 00:15:46.770 --> 00:15:48.130 align:middle line:90% is much more extreme than that. 00:15:48.130 --> 00:15:51.040 align:middle line:84% But the reason it's not very meaningful 00:15:51.040 --> 00:15:53.650 align:middle line:84% is essentially because the prices are not the same 00:15:53.650 --> 00:15:56.630 align:middle line:84% across different parts of the world. 00:15:56.630 --> 00:16:00.290 align:middle line:84% So we have a method to do that, to be 00:16:00.290 --> 00:16:01.830 align:middle line:84% able to compare across countries. 00:16:01.830 --> 00:16:05.270 align:middle line:84% And again, even for a given country over long periods 00:16:05.270 --> 00:16:09.500 align:middle line:84% of time, we make a correction to the GDP numbers 00:16:09.500 --> 00:16:14.300 align:middle line:84% we have and we correct them by what is called PPP, 00:16:14.300 --> 00:16:16.310 align:middle line:90% Purchasing Power Parity. 00:16:16.310 --> 00:16:19.100 align:middle line:90% And I'll explain what that is. 00:16:19.100 --> 00:16:24.260 align:middle line:84% So whenever you see comparisons of GDP per capita 00:16:24.260 --> 00:16:27.020 align:middle line:84% across countries, when somebody is doing a growth analysis, 00:16:27.020 --> 00:16:30.720 align:middle line:90% it's going to be PPP adjusted. 00:16:30.720 --> 00:16:33.475 align:middle line:84% Now let me explain the logic of PPP. 00:16:33.475 --> 00:16:36.616 align:middle line:90% 00:16:36.616 --> 00:16:41.150 align:middle line:84% And again, I said, within the same country or periods, 00:16:41.150 --> 00:16:44.180 align:middle line:84% perhaps not 300 years, but over periods of 40 years, 00:16:44.180 --> 00:16:48.170 align:middle line:84% it's reasonable to use just real GDP. 00:16:48.170 --> 00:16:52.970 align:middle line:84% But when you start comparing Botswana versus the US, 00:16:52.970 --> 00:16:55.790 align:middle line:84% it gets a lot trickier because there 00:16:55.790 --> 00:16:59.060 align:middle line:84% is a lot of goods that are a lot cheaper in poorer countries, 00:16:59.060 --> 00:17:00.930 align:middle line:90% in particular food. 00:17:00.930 --> 00:17:02.301 align:middle line:90% OK. 00:17:02.301 --> 00:17:04.650 align:middle line:84% And so you have to be careful with those comparisons. 00:17:04.650 --> 00:17:06.660 align:middle line:84% So I'm going to give you this example, which 00:17:06.660 --> 00:17:10.470 align:middle line:84% is somewhat hypothetical, but the numbers are not crazy. 00:17:10.470 --> 00:17:14.340 align:middle line:84% So suppose you have two economies, the US and Russia-- 00:17:14.340 --> 00:17:20.819 align:middle line:90% 00:17:20.819 --> 00:17:23.490 align:middle line:90% well, anyways. 00:17:23.490 --> 00:17:28.740 align:middle line:84% And suppose that in both economies, 00:17:28.740 --> 00:17:33.390 align:middle line:84% households and firms consume cars and food. 00:17:33.390 --> 00:17:37.020 align:middle line:84% And suppose that the average consumer in the US buys one car 00:17:37.020 --> 00:17:42.770 align:middle line:84% a year for $10,000 and a bundle of food for $10,000 as well, 00:17:42.770 --> 00:17:47.400 align:middle line:84% so the total expenditure in consumption for this household 00:17:47.400 --> 00:17:50.150 align:middle line:84% on average is about $20,000 a year. 00:17:50.150 --> 00:17:52.810 align:middle line:84% That's what a US household consumes. 00:17:52.810 --> 00:17:55.170 align:middle line:84% These numbers are fantasy numbers, 00:17:55.170 --> 00:17:59.400 align:middle line:84% but the big picture is not that fantasy. 00:17:59.400 --> 00:18:06.280 align:middle line:84% Russia, the average consumer buys 0.07 cars a year for 40,000 00:18:06.280 --> 00:18:10.570 align:middle line:84% rubles and the same bundle of food that in the US. 00:18:10.570 --> 00:18:11.770 align:middle line:90% Same, assume that. 00:18:11.770 --> 00:18:15.370 align:middle line:84% Same bundle of food good for 80,000 rubles. 00:18:15.370 --> 00:18:20.920 align:middle line:84% So the total expenditure of this average household in Russia is 00:18:20.920 --> 00:18:23.390 align:middle line:90% 120,000 rubles. 00:18:23.390 --> 00:18:26.660 align:middle line:84% Suppose that the exchange rate is 60 rubles per dollar. 00:18:26.660 --> 00:18:29.950 align:middle line:84% This thing has moved a lot in recent times, 00:18:29.950 --> 00:18:34.460 align:middle line:84% but suppose that's the number of rubles per dollar. 00:18:34.460 --> 00:18:37.720 align:middle line:84% So you divide $120,000, and you want to convert them 00:18:37.720 --> 00:18:42.280 align:middle line:84% into dollars, you divide the 120,000 rubles by 60,000 rubles 00:18:42.280 --> 00:18:45.970 align:middle line:84% per dollar, and then you get how much a Russian household 00:18:45.970 --> 00:18:50.470 align:middle line:84% on average spends on consumption in a year, 00:18:50.470 --> 00:18:53.230 align:middle line:90% and it's $2,000 a year. 00:18:53.230 --> 00:18:57.650 align:middle line:84% So here you have 120,000 divided by 60. it's 2,000. 00:18:57.650 --> 00:19:00.370 align:middle line:84% That's the number of dollars that an average household 00:19:00.370 --> 00:19:02.690 align:middle line:90% in Russia consumes. 00:19:02.690 --> 00:19:07.710 align:middle line:84% So the question is, you have a US household spends $20,000 00:19:07.710 --> 00:19:12.840 align:middle line:84% a year, a Russian household spends $2,000 a year. 00:19:12.840 --> 00:19:15.360 align:middle line:84% And the question is then, is Russia 00:19:15.360 --> 00:19:19.330 align:middle line:90% 10 times poorer than the US? 00:19:19.330 --> 00:19:21.660 align:middle line:90% OK. 00:19:21.660 --> 00:19:24.990 align:middle line:84% If you were to compare real GDP, that would be answer. 00:19:24.990 --> 00:19:26.790 align:middle line:90% Yeah. 00:19:26.790 --> 00:19:27.420 align:middle line:90% And it's true. 00:19:27.420 --> 00:19:31.650 align:middle line:84% If you look at, again, in this example, 00:19:31.650 --> 00:19:35.250 align:middle line:84% if you look at the real GDP numbers 00:19:35.250 --> 00:19:37.920 align:middle line:84% on the same year converted all into dollars, 00:19:37.920 --> 00:19:41.060 align:middle line:90% that answer is correct. 00:19:41.060 --> 00:19:42.770 align:middle line:84% But it doesn't represent-- the point 00:19:42.770 --> 00:19:44.300 align:middle line:84% is that it doesn't represent really 00:19:44.300 --> 00:19:47.150 align:middle line:84% the well-being of the average household in Russia 00:19:47.150 --> 00:19:49.070 align:middle line:90% for this reason, at least. 00:19:49.070 --> 00:19:49.915 align:middle line:90% Why not? 00:19:49.915 --> 00:19:53.290 align:middle line:90% 00:19:53.290 --> 00:19:58.810 align:middle line:84% But you ultimately matter is how much real goods the household 00:19:58.810 --> 00:20:00.830 align:middle line:90% consumes. 00:20:00.830 --> 00:20:02.540 align:middle line:90% That's what really matters. 00:20:02.540 --> 00:20:05.660 align:middle line:84% If you live in a country where the price of everything is zero, 00:20:05.660 --> 00:20:10.080 align:middle line:84% your consumption expenditure consumption will be zero. 00:20:10.080 --> 00:20:13.470 align:middle line:84% But that doesn't mean that you are as unhappy as somebody 00:20:13.470 --> 00:20:14.597 align:middle line:90% that consumes zero. 00:20:14.597 --> 00:20:15.930 align:middle line:90% You're consuming whatever it is. 00:20:15.930 --> 00:20:18.390 align:middle line:84% It happens that the prices tend to be very low. 00:20:18.390 --> 00:20:20.470 align:middle line:84% And that's essentially the story here. 00:20:20.470 --> 00:20:22.590 align:middle line:84% As I said before, it tends to be the case 00:20:22.590 --> 00:20:26.450 align:middle line:84% that in poorer countries, a lot of things are cheaper. 00:20:26.450 --> 00:20:29.340 align:middle line:84% There is certain very high-tech things 00:20:29.340 --> 00:20:32.265 align:middle line:84% that are not even consumed in poorer countries, 00:20:32.265 --> 00:20:33.890 align:middle line:84% so you have to adjust for that as well. 00:20:33.890 --> 00:20:37.190 align:middle line:84% But a lot of the regular things, the bulk of the purchases 00:20:37.190 --> 00:20:40.860 align:middle line:84% tend to be a lot cheaper in poorer countries. 00:20:40.860 --> 00:20:44.000 align:middle line:84% And that's exactly what is behind the reason why 00:20:44.000 --> 00:20:46.742 align:middle line:84% in this example, the answer is no. 00:20:46.742 --> 00:20:48.200 align:middle line:84% It's not true that the Russians are 00:20:48.200 --> 00:20:50.600 align:middle line:84% 10 times-- the Russian household in this example 00:20:50.600 --> 00:20:52.670 align:middle line:90% is 10 times poorer than the US. 00:20:52.670 --> 00:20:54.170 align:middle line:90% Let's check it. 00:20:54.170 --> 00:20:56.430 align:middle line:90% So that's our example. 00:20:56.430 --> 00:20:59.040 align:middle line:90% And I said, not so fast. 00:20:59.040 --> 00:21:01.930 align:middle line:84% Let's use-- so assume that the goods are the same, 00:21:01.930 --> 00:21:06.420 align:middle line:84% so the cars that the Russians buy is the same as the cars 00:21:06.420 --> 00:21:08.740 align:middle line:90% that the US households buy. 00:21:08.740 --> 00:21:12.670 align:middle line:84% That was truer a few months ago than now, 00:21:12.670 --> 00:21:15.100 align:middle line:90% but assume that's the case. 00:21:15.100 --> 00:21:19.140 align:middle line:84% It's just that the Russians change their cars 00:21:19.140 --> 00:21:20.280 align:middle line:90% less frequently. 00:21:20.280 --> 00:21:22.170 align:middle line:84% In this example, the US household 00:21:22.170 --> 00:21:26.550 align:middle line:84% is changing the car once a year, while the Russians are changing 00:21:26.550 --> 00:21:30.720 align:middle line:84% the car no less than once every 10 years, one every 15 years 00:21:30.720 --> 00:21:32.970 align:middle line:90% or so. 00:21:32.970 --> 00:21:36.150 align:middle line:84% Let's assume also that the bundle of food 00:21:36.150 --> 00:21:39.240 align:middle line:84% is exactly the same in both places. 00:21:39.240 --> 00:21:46.530 align:middle line:84% So since the car is the same and the bundle of food is the same, 00:21:46.530 --> 00:21:52.470 align:middle line:84% I can use US prices to measure ration consumption. 00:21:52.470 --> 00:21:59.490 align:middle line:84% And that's comparable to what US consumption is because I'm 00:21:59.490 --> 00:22:02.250 align:middle line:84% trying to convert the goods they're consuming into something 00:22:02.250 --> 00:22:05.080 align:middle line:84% that's comparable to what the US consumes. 00:22:05.080 --> 00:22:07.630 align:middle line:84% Since the goods themselves are the same, 00:22:07.630 --> 00:22:10.420 align:middle line:84% if I value them at the same price, either of the two prices, 00:22:10.420 --> 00:22:12.752 align:middle line:84% but at the same prices, then I'm going 00:22:12.752 --> 00:22:14.960 align:middle line:84% to be able to make the comparison that I really want. 00:22:14.960 --> 00:22:19.540 align:middle line:84% That's what PPP adjustment means. 00:22:19.540 --> 00:22:21.760 align:middle line:84% So look at our particular example. 00:22:21.760 --> 00:22:27.070 align:middle line:84% Here, the Russian household would be consuming 0.07 cars 00:22:27.070 --> 00:22:30.340 align:middle line:84% times $10,000, which is the price of a car, 00:22:30.340 --> 00:22:35.490 align:middle line:90% plus 1 unit of a bundle of food. 00:22:35.490 --> 00:22:38.530 align:middle line:84% And the US price is $10,000 for that. 00:22:38.530 --> 00:22:42.600 align:middle line:84% So the total consumption of the household, PPP adjusted, 00:22:42.600 --> 00:22:45.810 align:middle line:84% the Russian household is $10,700. 00:22:45.810 --> 00:22:46.710 align:middle line:90% OK. 00:22:46.710 --> 00:22:48.120 align:middle line:90% That's not 1/10. 00:22:48.120 --> 00:22:52.040 align:middle line:90% It's 53% of US consumption. 00:22:52.040 --> 00:22:56.920 align:middle line:84% So true, Russian household is poorer than an average US 00:22:56.920 --> 00:22:58.995 align:middle line:84% household, but it's not 10 times poorer. 00:22:58.995 --> 00:23:03.670 align:middle line:90% 00:23:03.670 --> 00:23:10.280 align:middle line:84% It's 53% as rich as the US household. 00:23:10.280 --> 00:23:12.220 align:middle line:90% And so this is big. 00:23:12.220 --> 00:23:14.980 align:middle line:84% And all the numbers I'm going to show you next, 00:23:14.980 --> 00:23:17.080 align:middle line:84% especially when we compare across countries that 00:23:17.080 --> 00:23:20.440 align:middle line:84% are very different in terms of level of development and so on, 00:23:20.440 --> 00:23:23.110 align:middle line:84% have these kind of corrections built in. 00:23:23.110 --> 00:23:25.600 align:middle line:84% If you need the data for these kind of things 00:23:25.600 --> 00:23:27.310 align:middle line:84% for whatever reason, you find them 00:23:27.310 --> 00:23:28.810 align:middle line:84% in what is called the Penn Tables. 00:23:28.810 --> 00:23:30.550 align:middle line:84% The Penn Tables is essentially collects 00:23:30.550 --> 00:23:32.830 align:middle line:84% all the national accounts of all places 00:23:32.830 --> 00:23:35.320 align:middle line:90% and makes these corrections. 00:23:35.320 --> 00:23:38.330 align:middle line:84% The problem is they don't update them very frequently. 00:23:38.330 --> 00:23:40.690 align:middle line:84% But if you look in, [? Fred, ?] for example, which 00:23:40.690 --> 00:23:42.730 align:middle line:84% is using one of the P sets, there 00:23:42.730 --> 00:23:45.580 align:middle line:84% will be numbers for a few countries that 00:23:45.580 --> 00:23:50.670 align:middle line:90% have this PPP adjustment. 00:23:50.670 --> 00:23:54.540 align:middle line:84% OK, so that's going to remain in the background now, 00:23:54.540 --> 00:23:57.150 align:middle line:84% but I just wanted to tell you how you construct numbers 00:23:57.150 --> 00:23:59.640 align:middle line:84% when you want to talk about long-run and comparison 00:23:59.640 --> 00:24:01.830 align:middle line:90% across countries. 00:24:01.830 --> 00:24:05.370 align:middle line:90% First set of numbers here. 00:24:05.370 --> 00:24:10.240 align:middle line:84% These are obviously all, today, at least, developed economies. 00:24:10.240 --> 00:24:13.070 align:middle line:84% Look at the growth between 1950, 2017. 00:24:13.070 --> 00:24:16.330 align:middle line:84% Obviously, the war created a big mess there, but before that, 00:24:16.330 --> 00:24:18.660 align:middle line:90% so let's start from 1950. 00:24:18.660 --> 00:24:22.740 align:middle line:84% And what you see here is France, on average during this period, 00:24:22.740 --> 00:24:23.640 align:middle line:90% France grew-- 00:24:23.640 --> 00:24:27.972 align:middle line:84% 2013 I think is the last-- yes, it's the last year. 00:24:27.972 --> 00:24:29.430 align:middle line:84% I think they were recently updated, 00:24:29.430 --> 00:24:31.680 align:middle line:84% but at least when the book was published, 00:24:31.680 --> 00:24:34.950 align:middle line:84% that was the last year they had Penn Tables for. 00:24:34.950 --> 00:24:41.162 align:middle line:84% But France grew, on average, 2.6% per year on average. 00:24:41.162 --> 00:24:42.870 align:middle line:84% They also had a business cycle and so on, 00:24:42.870 --> 00:24:45.300 align:middle line:90% but on average, 2.6% per year. 00:24:45.300 --> 00:24:47.983 align:middle line:84% Japan during this period grew by 4.1%. 00:24:47.983 --> 00:24:50.520 align:middle line:90% 00:24:50.520 --> 00:24:51.990 align:middle line:90% UK, 2.1%. 00:24:51.990 --> 00:24:53.540 align:middle line:90% The US, 2%. 00:24:53.540 --> 00:24:57.550 align:middle line:84% So the developed world essentially grew around 2.7% 00:24:57.550 --> 00:25:01.720 align:middle line:90% on average during this period. 00:25:01.720 --> 00:25:08.350 align:middle line:84% Look at the effect that this has on the level of GDP per person. 00:25:08.350 --> 00:25:11.560 align:middle line:90% And all these PPP are adjusted. 00:25:11.560 --> 00:25:15.380 align:middle line:84% For the case of France, 5.6 times. 00:25:15.380 --> 00:25:20.590 align:middle line:84% So they started with $7,000, and they were close to $40,000 00:25:20.590 --> 00:25:25.890 align:middle line:84% in 2017, so the ratio is raised 5.6. 00:25:25.890 --> 00:25:26.770 align:middle line:90% Look at the US. 00:25:26.770 --> 00:25:29.100 align:middle line:84% The US is 2%, and that ratio is-- 00:25:29.100 --> 00:25:33.930 align:middle line:84% it's still richer than France per person in 2017, 00:25:33.930 --> 00:25:38.140 align:middle line:84% but the ratio of that to that is smaller than that. 00:25:38.140 --> 00:25:40.140 align:middle line:84% So over a long period of time, that's 00:25:40.140 --> 00:25:41.910 align:middle line:84% what the trend in the picture capture. 00:25:41.910 --> 00:25:44.190 align:middle line:84% A small difference in the rate of growth, 00:25:44.190 --> 00:25:46.380 align:middle line:84% if they are sustained for a long period of time, 00:25:46.380 --> 00:25:48.360 align:middle line:84% can make quite a bit of difference 00:25:48.360 --> 00:25:51.240 align:middle line:90% for the change in GDP. 00:25:51.240 --> 00:25:57.140 align:middle line:84% And so what is the first-- what is the pattern-- 00:25:57.140 --> 00:25:59.270 align:middle line:90% let's find the pattern here. 00:25:59.270 --> 00:26:03.080 align:middle line:84% There's a very clear pattern in that picture, in that table. 00:26:03.080 --> 00:26:04.170 align:middle line:90% What is it? 00:26:04.170 --> 00:26:05.730 align:middle line:90% Can you spot it? 00:26:05.730 --> 00:26:16.960 align:middle line:90% 00:26:16.960 --> 00:26:21.400 align:middle line:84% I hadn't actually realized it when I was looking at my notes 00:26:21.400 --> 00:26:23.830 align:middle line:84% and then realized that it's very clear in this table. 00:26:23.830 --> 00:26:25.450 align:middle line:84% That's the reason I added this line, 00:26:25.450 --> 00:26:27.310 align:middle line:84% I updated the slide this morning. 00:26:27.310 --> 00:26:28.320 align:middle line:90% Do you see a pattern? 00:26:28.320 --> 00:26:34.100 align:middle line:90% 00:26:34.100 --> 00:26:35.200 align:middle line:90% Yes. 00:26:35.200 --> 00:26:38.470 align:middle line:84% AUDIENCE: The higher growth rate have a higher multiple. 00:26:38.470 --> 00:26:42.090 align:middle line:84% RICARDO CABALLERO: Yeah, Yes, but that's math. 00:26:42.090 --> 00:26:43.000 align:middle line:90% OK. 00:26:43.000 --> 00:26:46.620 align:middle line:84% So it's a true statement, but that's just math. 00:26:46.620 --> 00:26:50.500 align:middle line:84% There's an economic thing that I want to-- 00:26:50.500 --> 00:26:52.960 align:middle line:90% so you're right, but I want-- 00:26:52.960 --> 00:26:54.070 align:middle line:90% I should have clarified. 00:26:54.070 --> 00:26:55.695 align:middle line:84% There's an economic pattern there. 00:26:55.695 --> 00:27:03.610 align:middle line:90% 00:27:03.610 --> 00:27:05.090 align:middle line:90% Let me simplify. 00:27:05.090 --> 00:27:09.550 align:middle line:84% Just look at these two columns, because a higher number here 00:27:09.550 --> 00:27:11.650 align:middle line:90% simply-- 00:27:11.650 --> 00:27:12.150 align:middle line:90% sorry. 00:27:12.150 --> 00:27:14.832 align:middle line:84% A higher number here simply means that you 00:27:14.832 --> 00:27:16.040 align:middle line:90% have a higher rate of growth. 00:27:16.040 --> 00:27:17.400 align:middle line:90% That's your math facts. 00:27:17.400 --> 00:27:18.980 align:middle line:90% So ignore this column. 00:27:18.980 --> 00:27:21.520 align:middle line:84% What I suggest is that you just look at these two columns. 00:27:21.520 --> 00:27:25.380 align:middle line:90% 00:27:25.380 --> 00:27:27.980 align:middle line:90% Do you see a pattern? 00:27:27.980 --> 00:27:29.520 align:middle line:90% Just look at these two columns. 00:27:29.520 --> 00:27:32.630 align:middle line:84% This one, in a sense, just repeats information that is here 00:27:32.630 --> 00:27:34.140 align:middle line:90% for the reason you described. 00:27:34.140 --> 00:27:35.828 align:middle line:84% But just look at these two columns. 00:27:35.828 --> 00:27:36.870 align:middle line:90% Is there a pattern there? 00:27:36.870 --> 00:27:41.290 align:middle line:90% 00:27:41.290 --> 00:27:42.850 align:middle line:90% Exactly. 00:27:42.850 --> 00:27:43.840 align:middle line:90% Very important. 00:27:43.840 --> 00:27:45.510 align:middle line:84% Richer countries tend to grow slower. 00:27:45.510 --> 00:27:47.590 align:middle line:84% The richest country here is the US. 00:27:47.590 --> 00:27:51.770 align:middle line:84% Had the lowest rate of growth on average. 00:27:51.770 --> 00:27:54.890 align:middle line:84% The poorest was Japan there, and they 00:27:54.890 --> 00:27:57.040 align:middle line:90% had the highest rate of growth. 00:27:57.040 --> 00:27:57.932 align:middle line:90% OK. 00:27:57.932 --> 00:27:59.800 align:middle line:84% So that's a very important correlation. 00:27:59.800 --> 00:28:02.467 align:middle line:84% And again, the first model we're going to see of economic growth 00:28:02.467 --> 00:28:04.110 align:middle line:84% is going to explain that correlation. 00:28:04.110 --> 00:28:08.010 align:middle line:90% Why is it that we see that? 00:28:08.010 --> 00:28:09.523 align:middle line:90% Those were for five economies. 00:28:09.523 --> 00:28:10.690 align:middle line:90% You could say it's an axiom. 00:28:10.690 --> 00:28:12.780 align:middle line:90% But look at this. 00:28:12.780 --> 00:28:15.790 align:middle line:84% This is rich countries in general since 1950s. 00:28:15.790 --> 00:28:17.772 align:middle line:84% And you look at here in this axis, 00:28:17.772 --> 00:28:19.230 align:middle line:84% you have the annual rate of growth, 00:28:19.230 --> 00:28:22.110 align:middle line:84% the average rate of growth, and here, 00:28:22.110 --> 00:28:24.640 align:middle line:90% the GDP per person in 1950. 00:28:24.640 --> 00:28:27.300 align:middle line:84% So at the beginning of the sample, 1950, 00:28:27.300 --> 00:28:30.790 align:middle line:84% these countries have this level of GDP per capita. 00:28:30.790 --> 00:28:32.730 align:middle line:84% And then here is the rate of growth 00:28:32.730 --> 00:28:36.840 align:middle line:90% on average from 1950 to 1987. 00:28:36.840 --> 00:28:39.090 align:middle line:84% And it's very clear there that there's 00:28:39.090 --> 00:28:42.180 align:middle line:90% a downward sloping pattern, no? 00:28:42.180 --> 00:28:45.540 align:middle line:84% So that's the same fact now for many more countries, 00:28:45.540 --> 00:28:47.970 align:middle line:84% this it's a downward-sloping relationship. 00:28:47.970 --> 00:28:50.730 align:middle line:84% The richest countries tend to grow much slower 00:28:50.730 --> 00:28:52.293 align:middle line:84% than the countries that were poorer 00:28:52.293 --> 00:28:53.585 align:middle line:90% at the beginning of the sample. 00:28:53.585 --> 00:28:56.950 align:middle line:90% 00:28:56.950 --> 00:29:01.130 align:middle line:84% There are some interesting outliers, like Mexico, 00:29:01.130 --> 00:29:04.390 align:middle line:90% and it's interesting in itself. 00:29:04.390 --> 00:29:09.070 align:middle line:84% I'm not going to say a lot about why that's the case, 00:29:09.070 --> 00:29:14.740 align:middle line:84% but let me for now stick to the pattern, the dominant pattern, 00:29:14.740 --> 00:29:18.587 align:middle line:84% which is a downward-sloping relationship. 00:29:18.587 --> 00:29:19.920 align:middle line:90% That's another way of seeing it. 00:29:19.920 --> 00:29:23.520 align:middle line:84% And this is for just a bigger variety of countries. 00:29:23.520 --> 00:29:27.590 align:middle line:84% I have Botswana, China, Thailand, and so on. 00:29:27.590 --> 00:29:31.640 align:middle line:84% And you see here, GDP at the beginning of the 1950 00:29:31.640 --> 00:29:34.040 align:middle line:90% and GDP by 2018. 00:29:34.040 --> 00:29:35.990 align:middle line:84% And the pattern here, which is essentially 00:29:35.990 --> 00:29:38.330 align:middle line:84% a repetition of the pattern that I showed you before, 00:29:38.330 --> 00:29:43.115 align:middle line:84% is that there is much more compression here than here. 00:29:43.115 --> 00:29:45.780 align:middle line:90% 00:29:45.780 --> 00:29:48.850 align:middle line:84% How can you have more compassion here than here? 00:29:48.850 --> 00:29:52.530 align:middle line:84% Well, because there is some sort of convergence. 00:29:52.530 --> 00:29:53.930 align:middle line:90% There is a sense of convergence. 00:29:53.930 --> 00:29:56.220 align:middle line:84% It's that those that were poorer tend 00:29:56.220 --> 00:30:00.030 align:middle line:84% to grow a little faster than those that were richer, 00:30:00.030 --> 00:30:02.530 align:middle line:84% and therefore they tend to converge to each other. 00:30:02.530 --> 00:30:05.340 align:middle line:84% So that's the point I'm highlighting here. 00:30:05.340 --> 00:30:09.990 align:middle line:84% A lot of this pressure, 1950, much less dispersion in 2018. 00:30:09.990 --> 00:30:13.200 align:middle line:84% That means that on average, the poorer countries 00:30:13.200 --> 00:30:15.790 align:middle line:84% are growing faster than the richer countries. 00:30:15.790 --> 00:30:20.170 align:middle line:90% 00:30:20.170 --> 00:30:22.240 align:middle line:84% And again, all this is per capita, PPP 00:30:22.240 --> 00:30:23.380 align:middle line:90% adjusted, and all that. 00:30:23.380 --> 00:30:30.160 align:middle line:90% 00:30:30.160 --> 00:30:35.140 align:middle line:84% This picture, again, sort of makes the point, 00:30:35.140 --> 00:30:40.040 align:middle line:84% but now it takes many more countries. 00:30:40.040 --> 00:30:41.300 align:middle line:90% The point of this picture-- 00:30:41.300 --> 00:30:42.320 align:middle line:90% it's in the book-- 00:30:42.320 --> 00:30:45.080 align:middle line:90% is to highlight that-- 00:30:45.080 --> 00:30:46.520 align:middle line:84% it's a little messy, the picture, 00:30:46.520 --> 00:30:50.920 align:middle line:84% but to highlight that if you look in different regions, 00:30:50.920 --> 00:30:55.240 align:middle line:84% OECD is the major economies, tend to-- 00:30:55.240 --> 00:30:57.010 align:middle line:90% the pattern I showed you holds. 00:30:57.010 --> 00:31:01.060 align:middle line:84% If you only isolate only the blue squares, 00:31:01.060 --> 00:31:03.960 align:middle line:84% you tend to see that negative relationship. 00:31:03.960 --> 00:31:10.980 align:middle line:84% If you look at within Asia, it's a little bit noisier, 00:31:10.980 --> 00:31:16.212 align:middle line:84% but you also tend to see a negative relationship. 00:31:16.212 --> 00:31:22.830 align:middle line:84% If you look at Africa, that relationship is lost completely. 00:31:22.830 --> 00:31:24.460 align:middle line:90% OK. 00:31:24.460 --> 00:31:28.510 align:middle line:84% So when you look at the world as a whole, 00:31:28.510 --> 00:31:31.360 align:middle line:84% the picture is not as neat as the one I showed you 00:31:31.360 --> 00:31:33.610 align:middle line:84% because there are certain pockets of the world that 00:31:33.610 --> 00:31:35.620 align:middle line:84% are not behaving according to the kind of models 00:31:35.620 --> 00:31:38.150 align:middle line:84% I want to discuss in the next few lectures. 00:31:38.150 --> 00:31:39.650 align:middle line:84% And the reason they're not behaving, 00:31:39.650 --> 00:31:42.460 align:middle line:84% is entirely-- it's almost outside economics. 00:31:42.460 --> 00:31:45.580 align:middle line:84% It's political conflicts, wars, and things 00:31:45.580 --> 00:31:48.130 align:middle line:84% of that nature which continuously disrupt 00:31:48.130 --> 00:31:50.110 align:middle line:84% the economic forces that I'm going to highlight 00:31:50.110 --> 00:31:51.470 align:middle line:90% in the next few lectures. 00:31:51.470 --> 00:31:54.150 align:middle line:90% OK. 00:31:54.150 --> 00:31:58.550 align:middle line:90% So that's a different issue. 00:31:58.550 --> 00:32:00.950 align:middle line:84% All the models I'll show you next 00:32:00.950 --> 00:32:10.940 align:middle line:84% are about the blue and the green squares and triangles there. 00:32:10.940 --> 00:32:12.175 align:middle line:90% Not about the red ones. 00:32:12.175 --> 00:32:16.580 align:middle line:90% 00:32:16.580 --> 00:32:19.460 align:middle line:84% So I show you what happens across countries 00:32:19.460 --> 00:32:24.530 align:middle line:84% over a certain period of time, which is long but not that long. 00:32:24.530 --> 00:32:29.230 align:middle line:84% Here you see what happens in longer history. 00:32:29.230 --> 00:32:31.720 align:middle line:84% There are two patterns that I like to highlight here, 00:32:31.720 --> 00:32:36.550 align:middle line:84% is that first, for a while you didn't see much, 00:32:36.550 --> 00:32:39.940 align:middle line:84% but you tend to see a big acceleration, 00:32:39.940 --> 00:32:46.780 align:middle line:84% in the Western world especially, around the 1950s or so. 00:32:46.780 --> 00:32:49.990 align:middle line:84% So clearly the Western world was growing faster 00:32:49.990 --> 00:32:51.910 align:middle line:90% than the rest of the world. 00:32:51.910 --> 00:32:53.050 align:middle line:90% The Western hemisphere. 00:32:53.050 --> 00:33:03.840 align:middle line:84% This is a more [INAUDIBLE] type and grouping. 00:33:03.840 --> 00:33:06.870 align:middle line:84% And you see that there's a very fast acceleration 00:33:06.870 --> 00:33:09.530 align:middle line:90% in growth in this episode here. 00:33:09.530 --> 00:33:13.280 align:middle line:84% Western Europe was also flattish and then 00:33:13.280 --> 00:33:15.260 align:middle line:90% picked up very strongly there. 00:33:15.260 --> 00:33:17.400 align:middle line:84% And you see the different regions of the world. 00:33:17.400 --> 00:33:21.110 align:middle line:84% And again, you see the sub-Saharan Africa region 00:33:21.110 --> 00:33:23.650 align:middle line:84% that sort of hasn't really picked up. 00:33:23.650 --> 00:33:24.150 align:middle line:90% OK. 00:33:24.150 --> 00:33:28.500 align:middle line:90% 00:33:28.500 --> 00:33:30.630 align:middle line:90% Much longer history. 00:33:30.630 --> 00:33:33.430 align:middle line:84% Well, that's the way it looks for the world as a whole. 00:33:33.430 --> 00:33:35.490 align:middle line:90% OK. 00:33:35.490 --> 00:33:37.470 align:middle line:84% Exponential pictures tend to look like that, 00:33:37.470 --> 00:33:40.410 align:middle line:84% but this is more dramatic than exponential. 00:33:40.410 --> 00:33:46.580 align:middle line:84% And again, what happened here is going 00:33:46.580 --> 00:33:50.030 align:middle line:84% to be very different from the kind of models 00:33:50.030 --> 00:33:52.190 align:middle line:90% I'll describe next. 00:33:52.190 --> 00:33:54.200 align:middle line:84% This period here is mostly dominated 00:33:54.200 --> 00:33:58.490 align:middle line:84% by what's called the Malthusian era, which is essentially 00:33:58.490 --> 00:34:01.430 align:middle line:84% people live, population grew, and so on, 00:34:01.430 --> 00:34:05.870 align:middle line:84% depending on how good was the harvest that year and so on. 00:34:05.870 --> 00:34:09.429 align:middle line:84% So you had this model in which this population grew faster. 00:34:09.429 --> 00:34:12.335 align:middle line:84% There was a main driver of growth. 00:34:12.335 --> 00:34:14.210 align:middle line:84% Well, but, you know, there wasn't enough food 00:34:14.210 --> 00:34:17.239 align:middle line:84% to sustain a higher population, and then you stay. 00:34:17.239 --> 00:34:20.179 align:middle line:84% So there was a fight between food and people 00:34:20.179 --> 00:34:24.300 align:middle line:84% and not much space for-- most people were in agriculture, 00:34:24.300 --> 00:34:29.929 align:middle line:84% and there wasn't much to build on. 00:34:29.929 --> 00:34:32.489 align:middle line:84% Nowadays there are pockets in the world, 00:34:32.489 --> 00:34:35.330 align:middle line:84% and we had the severe situations during COVID, 00:34:35.330 --> 00:34:38.239 align:middle line:84% but food is not really a constraint for growth 00:34:38.239 --> 00:34:39.810 align:middle line:90% for the world as a whole. 00:34:39.810 --> 00:34:40.310 align:middle line:90% OK. 00:34:40.310 --> 00:34:43.730 align:middle line:90% 00:34:43.730 --> 00:34:49.409 align:middle line:84% So, in other words, had you taken this course in year 1,000 00:34:49.409 --> 00:34:53.159 align:middle line:84% or in the Renaissance, nobody would have talked about growth. 00:34:53.159 --> 00:34:55.590 align:middle line:84% It's not something that happened, really. 00:34:55.590 --> 00:34:58.080 align:middle line:84% It's a very modern thing to think 00:34:58.080 --> 00:35:01.090 align:middle line:84% about these pictures with these long trends and so on. 00:35:01.090 --> 00:35:01.590 align:middle line:90% OK. 00:35:01.590 --> 00:35:04.055 align:middle line:90% 00:35:04.055 --> 00:35:06.430 align:middle line:84% You would have talked about a lot more interesting things 00:35:06.430 --> 00:35:10.390 align:middle line:84% than this, but not about growth, that's for sure. 00:35:10.390 --> 00:35:13.570 align:middle line:84% And growth, the last point I think I want to make about this 00:35:13.570 --> 00:35:16.243 align:middle line:90% is it makes a big difference. 00:35:16.243 --> 00:35:17.660 align:middle line:84% I don't know if you can read that. 00:35:17.660 --> 00:35:18.410 align:middle line:90% I can't. 00:35:18.410 --> 00:35:22.780 align:middle line:84% But what I have here is GDP per capita 00:35:22.780 --> 00:35:27.800 align:middle line:84% in 1950 versus GDP per capita in 2016. 00:35:27.800 --> 00:35:30.890 align:middle line:84% And you have these isochrons here. 00:35:30.890 --> 00:35:32.040 align:middle line:90% As you move up-- 00:35:32.040 --> 00:35:35.530 align:middle line:84% so this line here is what happens to countries. 00:35:35.530 --> 00:35:40.120 align:middle line:84% It's a 45-degree line, so if you are on the 45-degree line, 00:35:40.120 --> 00:35:42.780 align:middle line:84% means that you haven't grown at all during this period. 00:35:42.780 --> 00:35:46.780 align:middle line:84% No, because that means that your GDP per capita in 1950 00:35:46.780 --> 00:35:50.690 align:middle line:84% is the same as your GDP per capita in 2016. 00:35:50.690 --> 00:35:52.920 align:middle line:84% That means on average, you didn't grow. 00:35:52.920 --> 00:35:56.160 align:middle line:84% But as I keep moving these lines up, 00:35:56.160 --> 00:35:58.415 align:middle line:84% it means you grew faster and faster and faster. 00:35:58.415 --> 00:36:01.995 align:middle line:90% 00:36:01.995 --> 00:36:04.530 align:middle line:84% And if you move along this line here, 00:36:04.530 --> 00:36:06.840 align:middle line:84% that means you have negative growth on average 00:36:06.840 --> 00:36:08.120 align:middle line:90% during that period. 00:36:08.120 --> 00:36:13.650 align:middle line:84% So each of these lines represents multiples. 00:36:13.650 --> 00:36:18.130 align:middle line:84% For example, this top line here is 30 times richer. 00:36:18.130 --> 00:36:21.000 align:middle line:84% These are guys that grew very fast. 00:36:21.000 --> 00:36:24.380 align:middle line:84% I cannot read either, but I sort of know who is in each place. 00:36:24.380 --> 00:36:27.390 align:middle line:90% 00:36:27.390 --> 00:36:28.750 align:middle line:90% This is an example here. 00:36:28.750 --> 00:36:31.800 align:middle line:90% This is Taiwan. 00:36:31.800 --> 00:36:37.290 align:middle line:84% This is Taiwan, and this is Singapore. 00:36:37.290 --> 00:36:38.370 align:middle line:90% They have a name. 00:36:38.370 --> 00:36:42.420 align:middle line:90% How do we call those countries? 00:36:42.420 --> 00:36:47.640 align:middle line:90% No, well-- the Asian Tigers. 00:36:47.640 --> 00:36:53.370 align:middle line:84% They grew very strong for a long time since the '60s or so. 00:36:53.370 --> 00:36:54.810 align:middle line:90% But there you see. 00:36:54.810 --> 00:36:56.100 align:middle line:90% You can compare. 00:36:56.100 --> 00:37:01.110 align:middle line:84% If you could see, you would see that Taiwan 00:37:01.110 --> 00:37:07.620 align:middle line:84% and the Democratic Republic of Congo had the same GDP in 1950. 00:37:07.620 --> 00:37:12.290 align:middle line:84% Now the Democratic Republic of Congo 00:37:12.290 --> 00:37:17.210 align:middle line:84% has less GDP than it had in 1950. 00:37:17.210 --> 00:37:21.770 align:middle line:84% It had $1,700 here and $800 today, 00:37:21.770 --> 00:37:26.730 align:middle line:84% while Taiwan has 30 times what it used to have. 00:37:26.730 --> 00:37:28.920 align:middle line:84% And so today, Taiwan is one of the richest economies 00:37:28.920 --> 00:37:30.310 align:middle line:90% in the world. 00:37:30.310 --> 00:37:33.960 align:middle line:84% It's close to $50,000 per capita, 00:37:33.960 --> 00:37:38.353 align:middle line:84% while the Republic of Congo has $700-- 00:37:38.353 --> 00:37:41.280 align:middle line:90% 00:37:41.280 --> 00:37:43.230 align:middle line:90% $800 per capita. 00:37:43.230 --> 00:37:46.550 align:middle line:84% So growth makes a big difference. 00:37:46.550 --> 00:37:48.830 align:middle line:84% And these are not that many years. 00:37:48.830 --> 00:37:52.490 align:middle line:90% This is just 70 years. 00:37:52.490 --> 00:37:55.820 align:middle line:84% And I can assure you that these people, they 00:37:55.820 --> 00:37:59.120 align:middle line:84% have other concerns, but their standard of living 00:37:59.120 --> 00:38:00.990 align:middle line:84% is a lot higher than these people. 00:38:00.990 --> 00:38:02.580 align:middle line:84% And at some point, they were the same. 00:38:02.580 --> 00:38:05.390 align:middle line:84% The big difference is some countries grew 00:38:05.390 --> 00:38:09.170 align:middle line:90% and some countries got stuck. 00:38:09.170 --> 00:38:11.210 align:middle line:90% Where is Argentina here? 00:38:11.210 --> 00:38:11.850 align:middle line:90% I don't know. 00:38:11.850 --> 00:38:14.520 align:middle line:90% Somewhere here, probably. 00:38:14.520 --> 00:38:15.578 align:middle line:90% It's Argentina. 00:38:15.578 --> 00:38:19.790 align:middle line:90% 00:38:19.790 --> 00:38:20.540 align:middle line:90% I don't know. 00:38:20.540 --> 00:38:22.820 align:middle line:90% I cannot see. 00:38:22.820 --> 00:38:24.830 align:middle line:90% I'll have a better chance here. 00:38:24.830 --> 00:38:26.000 align:middle line:90% I cannot see. 00:38:26.000 --> 00:38:26.670 align:middle line:90% OK, good. 00:38:26.670 --> 00:38:28.410 align:middle line:84% So growth does make a difference. 00:38:28.410 --> 00:38:31.080 align:middle line:84% And it has made a huge-- the world we see today 00:38:31.080 --> 00:38:34.160 align:middle line:84% and the countries we think as rich or poor 00:38:34.160 --> 00:38:37.670 align:middle line:84% were not the same countries that you thought in those terms 00:38:37.670 --> 00:38:39.770 align:middle line:90% in 1950. 00:38:39.770 --> 00:38:42.510 align:middle line:84% Asia is one of the most prominent differences. 00:38:42.510 --> 00:38:49.900 align:middle line:84% They have massive growth through the '60s starting with Japan, 00:38:49.900 --> 00:38:51.170 align:middle line:90% but then the rest. 00:38:51.170 --> 00:38:53.050 align:middle line:84% And again, were the famous Tigers-- 00:38:53.050 --> 00:39:00.230 align:middle line:84% Hong Kong, Taiwan, Singapore, and Korea. 00:39:00.230 --> 00:39:00.970 align:middle line:90% South Korea. 00:39:00.970 --> 00:39:03.560 align:middle line:90% 00:39:03.560 --> 00:39:04.280 align:middle line:90% Good. 00:39:04.280 --> 00:39:10.370 align:middle line:84% So let's start building some models of what we have just 00:39:10.370 --> 00:39:11.990 align:middle line:90% seen. 00:39:11.990 --> 00:39:14.360 align:middle line:84% Remember, when we look at the short run, 00:39:14.360 --> 00:39:17.530 align:middle line:84% we really didn't care about the supply side of the economy. 00:39:17.530 --> 00:39:19.110 align:middle line:84% Remember, it was all about demand. 00:39:19.110 --> 00:39:21.140 align:middle line:84% They said, well, demand, look what 00:39:21.140 --> 00:39:25.280 align:middle line:84% consumers, investment firms, and governments do with demand. 00:39:25.280 --> 00:39:26.960 align:middle line:90% That determines output. 00:39:26.960 --> 00:39:28.440 align:middle line:90% And how output happens? 00:39:28.440 --> 00:39:29.730 align:middle line:90% Well, it happens. 00:39:29.730 --> 00:39:31.920 align:middle line:84% We didn't really care too much about it. 00:39:31.920 --> 00:39:34.100 align:middle line:84% Then when we talked about the medium term, 00:39:34.100 --> 00:39:38.960 align:middle line:84% we say, OK, no, no, we have to care because to produce, 00:39:38.960 --> 00:39:42.260 align:middle line:84% you need workers, and workers are not 00:39:42.260 --> 00:39:43.880 align:middle line:84% going to work for any wage, and so 00:39:43.880 --> 00:39:48.830 align:middle line:84% we have to begin to talk about the supply side of the economy. 00:39:48.830 --> 00:39:50.610 align:middle line:90% But we made it very simple. 00:39:50.610 --> 00:39:53.180 align:middle line:84% We just looked at the problem of wage bargaining and price 00:39:53.180 --> 00:39:54.000 align:middle line:90% setting. 00:39:54.000 --> 00:39:56.670 align:middle line:84% But the production function itself wasn't that interesting. 00:39:56.670 --> 00:39:58.410 align:middle line:90% It was output equal to labor. 00:39:58.410 --> 00:40:00.170 align:middle line:84% And I told you it's very unrealistic, 00:40:00.170 --> 00:40:03.210 align:middle line:84% but it was convenient for that part of the course 00:40:03.210 --> 00:40:05.800 align:middle line:84% because capital doesn't grow that fast. 00:40:05.800 --> 00:40:08.280 align:middle line:84% So typical production function will have both capital 00:40:08.280 --> 00:40:11.340 align:middle line:84% and labor, but at the business cycle frequency, 00:40:11.340 --> 00:40:13.740 align:middle line:84% investment, the change in capital can be large, 00:40:13.740 --> 00:40:16.200 align:middle line:84% but the stock of capital doesn't move that much and so you 00:40:16.200 --> 00:40:19.150 align:middle line:84% can ignore it for business cycle type fluctuations. 00:40:19.150 --> 00:40:20.940 align:middle line:84% But if we want to look at the long run, 00:40:20.940 --> 00:40:23.770 align:middle line:84% capital plays a huge role, capital accumulation. 00:40:23.770 --> 00:40:27.120 align:middle line:84% And so we have to be explicit about the role of capital 00:40:27.120 --> 00:40:28.250 align:middle line:90% in the production function. 00:40:28.250 --> 00:40:31.012 align:middle line:90% 00:40:31.012 --> 00:40:33.220 align:middle line:84% And now we're going to forget about aggregate demand. 00:40:33.220 --> 00:40:34.650 align:middle line:84% We're going to say, look, we're going 00:40:34.650 --> 00:40:36.650 align:middle line:84% to focus about aggregate supply, and demand will 00:40:36.650 --> 00:40:37.780 align:middle line:90% do whatever it needs to do. 00:40:37.780 --> 00:40:43.080 align:middle line:84% So we get what the supply side says. 00:40:43.080 --> 00:40:48.240 align:middle line:84% So output now will be an increasing function 00:40:48.240 --> 00:40:50.850 align:middle line:90% of both capital and labor. 00:40:50.850 --> 00:40:52.420 align:middle line:90% [INAUDIBLE] 00:40:52.420 --> 00:40:57.070 align:middle line:84% Now this function will have a bunch of properties, 00:40:57.070 --> 00:40:59.230 align:middle line:90% many of which are-- 00:40:59.230 --> 00:41:02.260 align:middle line:84% no, at a broad level, they are empirically validated, 00:41:02.260 --> 00:41:04.600 align:middle line:84% but they are also very convenient from the modern point 00:41:04.600 --> 00:41:05.380 align:middle line:90% of view. 00:41:05.380 --> 00:41:10.120 align:middle line:84% The first and most important property 00:41:10.120 --> 00:41:14.055 align:middle line:90% is constant returns to scale. 00:41:14.055 --> 00:41:15.680 align:middle line:84% We're going to use a lot of properties, 00:41:15.680 --> 00:41:18.850 align:middle line:90% so please get that concept. 00:41:18.850 --> 00:41:22.120 align:middle line:84% Constant returns to scale means simply 00:41:22.120 --> 00:41:25.810 align:middle line:84% that if you scale the factors of production, 00:41:25.810 --> 00:41:28.300 align:middle line:90% you also scale the output. 00:41:28.300 --> 00:41:28.870 align:middle line:90% OK. 00:41:28.870 --> 00:41:33.640 align:middle line:84% So say if x is 1.1, that means if you 00:41:33.640 --> 00:41:39.010 align:middle line:84% increase capital and labor by 10%, you get 10% more output. 00:41:39.010 --> 00:41:39.580 align:middle line:90% OK. 00:41:39.580 --> 00:41:41.690 align:middle line:84% So that's constant returns to scale. 00:41:41.690 --> 00:41:43.510 align:middle line:84% If I scale all the factors of production 00:41:43.510 --> 00:41:46.120 align:middle line:84% by the same amount, the same proportion, 00:41:46.120 --> 00:41:48.920 align:middle line:84% then output grows by the same proportion. 00:41:48.920 --> 00:41:50.545 align:middle line:90% It's scalable. 00:41:50.545 --> 00:41:52.545 align:middle line:84% That's what it means, constant returns to scale. 00:41:52.545 --> 00:41:55.590 align:middle line:90% 00:41:55.590 --> 00:41:59.290 align:middle line:84% Very important property what comes next-- 00:41:59.290 --> 00:42:00.975 align:middle line:90% decreasing returns to capital. 00:42:00.975 --> 00:42:03.930 align:middle line:90% 00:42:03.930 --> 00:42:09.380 align:middle line:84% That is, as you increase capital for a fixed amount of labor-- 00:42:09.380 --> 00:42:11.410 align:middle line:84% so constant returns to scale is a property 00:42:11.410 --> 00:42:14.183 align:middle line:90% of a scaling everything up. 00:42:14.183 --> 00:42:15.850 align:middle line:84% The property I'm describing here is what 00:42:15.850 --> 00:42:17.510 align:middle line:90% happens if we increase only k. 00:42:17.510 --> 00:42:21.645 align:middle line:84% What happens to output if we increase only k but fixing n? 00:42:21.645 --> 00:42:24.170 align:middle line:90% 00:42:24.170 --> 00:42:25.800 align:middle line:90% In other words. 00:42:25.800 --> 00:42:30.008 align:middle line:84% set this to one, and it start moving this up. 00:42:30.008 --> 00:42:31.300 align:middle line:90% You're not going to get x here. 00:42:31.300 --> 00:42:34.510 align:middle line:84% You're going to get something different from x. 00:42:34.510 --> 00:42:37.060 align:middle line:84% What this tells you is that, yes, you're 00:42:37.060 --> 00:42:41.230 align:middle line:84% going to get more output, but less and less the more capital 00:42:41.230 --> 00:42:43.050 align:middle line:90% you have. 00:42:43.050 --> 00:42:45.840 align:middle line:84% So this says, for example, suppose 00:42:45.840 --> 00:42:49.500 align:middle line:84% that you start with 100 workers and 100 units of capital, 00:42:49.500 --> 00:42:53.960 align:middle line:84% and it happens that this produces 100 units of goods. 00:42:53.960 --> 00:42:57.850 align:middle line:84% If you add now 10 units of capital, 00:42:57.850 --> 00:43:03.100 align:middle line:84% say you're going to get seven units of output. 00:43:03.100 --> 00:43:05.980 align:middle line:84% Not 10, seven, because you didn't increase labor. 00:43:05.980 --> 00:43:07.720 align:middle line:84% Had I increased labor also by 10, 00:43:07.720 --> 00:43:09.110 align:middle line:84% I would have gotten 10 of output, 00:43:09.110 --> 00:43:12.920 align:middle line:84% but I've been increasing only capital by 10, 00:43:12.920 --> 00:43:16.450 align:middle line:84% then I'm keeping output fixed-- then labor fixed, 00:43:16.450 --> 00:43:19.390 align:middle line:84% then output will increase by less than 10. 00:43:19.390 --> 00:43:21.790 align:middle line:84% But what this decreasing returns to capital says 00:43:21.790 --> 00:43:23.770 align:middle line:84% is that now if you increase again 00:43:23.770 --> 00:43:26.680 align:middle line:84% from 110 to 120 units of capital, 00:43:26.680 --> 00:43:29.530 align:middle line:84% you're going to get less than seven units of output more. 00:43:29.530 --> 00:43:31.030 align:middle line:90% You're going to get five. 00:43:31.030 --> 00:43:33.532 align:middle line:84% And if you increase again from 120 to 130, 00:43:33.532 --> 00:43:34.990 align:middle line:84% you're going to get less than five. 00:43:34.990 --> 00:43:36.460 align:middle line:90% You're going to get three. 00:43:36.460 --> 00:43:37.870 align:middle line:90% And so on and so forth. 00:43:37.870 --> 00:43:41.080 align:middle line:84% That's decreasing returns to scale-- 00:43:41.080 --> 00:43:42.560 align:middle line:90% decreasing returns to capital. 00:43:42.560 --> 00:43:46.270 align:middle line:84% And the reason for that economically 00:43:46.270 --> 00:43:48.640 align:middle line:84% is that more and more capital is working 00:43:48.640 --> 00:43:50.980 align:middle line:84% with a fixed number of workers, so labor becomes 00:43:50.980 --> 00:43:53.670 align:middle line:90% very scarce for capital. 00:43:53.670 --> 00:43:54.930 align:middle line:90% And that's the reason. 00:43:54.930 --> 00:43:57.977 align:middle line:90% So you have very little of-- 00:43:57.977 --> 00:44:00.310 align:middle line:84% these are factors of production which are complementary. 00:44:00.310 --> 00:44:02.460 align:middle line:84% They need each other, labor and capital. 00:44:02.460 --> 00:44:05.770 align:middle line:84% You fix one, and it starts increasing only one, 00:44:05.770 --> 00:44:09.120 align:middle line:84% then it's harder and harder for each extra new unit of this one 00:44:09.120 --> 00:44:12.940 align:middle line:84% to work with fewer and fewer of the other factor of production. 00:44:12.940 --> 00:44:15.040 align:middle line:84% So the same principle applies to labor. 00:44:15.040 --> 00:44:18.240 align:middle line:84% If you fix capital and you only increase labor, 00:44:18.240 --> 00:44:21.172 align:middle line:84% then initially you're going to get a big jump in output, 00:44:21.172 --> 00:44:23.880 align:middle line:84% but it's going to be smaller and smaller and smaller the more you 00:44:23.880 --> 00:44:28.130 align:middle line:90% keep adding labor. 00:44:28.130 --> 00:44:31.260 align:middle line:90% 00:44:31.260 --> 00:44:37.920 align:middle line:84% So one x that we're going to use throughout 00:44:37.920 --> 00:44:40.450 align:middle line:90% is we want to make x-- 00:44:40.450 --> 00:44:44.650 align:middle line:84% one of our favorite x will be 1 over n. 00:44:44.650 --> 00:44:47.390 align:middle line:90% 00:44:47.390 --> 00:44:48.640 align:middle line:90% You see what I'm trying to do. 00:44:48.640 --> 00:44:51.160 align:middle line:84% When we set x equal to 1 over n, so 00:44:51.160 --> 00:44:58.300 align:middle line:84% that x equal to 1 over n, what I get here is output per person. 00:44:58.300 --> 00:44:58.800 align:middle line:90% No? 00:44:58.800 --> 00:45:01.210 align:middle line:90% That's what I get. 00:45:01.210 --> 00:45:03.340 align:middle line:90% y over n. 00:45:03.340 --> 00:45:07.150 align:middle line:84% So if I set x equal to 1 over n, I 00:45:07.150 --> 00:45:09.050 align:middle line:84% can use some constant returns to scale. 00:45:09.050 --> 00:45:13.780 align:middle line:84% I know that this is equal to y over n, k over n, n over n, 00:45:13.780 --> 00:45:16.930 align:middle line:84% so that is one, so this guy doesn't move. 00:45:16.930 --> 00:45:21.540 align:middle line:84% And I have now that output per person 00:45:21.540 --> 00:45:23.970 align:middle line:84% is increasing in capital per worker. 00:45:23.970 --> 00:45:26.470 align:middle line:84% Worker and population, this part of the course are the same. 00:45:26.470 --> 00:45:28.300 align:middle line:90% Forget unemployment. 00:45:28.300 --> 00:45:31.360 align:middle line:90% Any population is employment. 00:45:31.360 --> 00:45:33.550 align:middle line:90% Labor force is everything. 00:45:33.550 --> 00:45:36.280 align:middle line:84% This is not a place to worry about unemployment. 00:45:36.280 --> 00:45:42.720 align:middle line:90% 00:45:42.720 --> 00:45:46.530 align:middle line:84% OK, so remember that all the plots I showed you, 00:45:46.530 --> 00:45:48.870 align:middle line:84% the different figures, were about this variable-- 00:45:48.870 --> 00:45:51.480 align:middle line:84% how it change over time, how it was different 00:45:51.480 --> 00:45:54.390 align:middle line:84% across different countries, how it grew at a different rate 00:45:54.390 --> 00:45:56.820 align:middle line:90% in different countries. 00:45:56.820 --> 00:45:59.700 align:middle line:84% But from this very simple model, you 00:45:59.700 --> 00:46:05.220 align:middle line:84% see that in order to explain the change in this growth in y 00:46:05.220 --> 00:46:08.190 align:middle line:84% over n and why one country grows more than the other, 00:46:08.190 --> 00:46:11.360 align:middle line:84% you have with the simple model only two options. 00:46:11.360 --> 00:46:14.100 align:middle line:90% 00:46:14.100 --> 00:46:19.620 align:middle line:84% So if I tell you country A grew more over this period than-- 00:46:19.620 --> 00:46:25.620 align:middle line:84% grew more per person than this other country 00:46:25.620 --> 00:46:29.760 align:middle line:84% over this period of time, there are only two options here. 00:46:29.760 --> 00:46:32.200 align:middle line:84% The first one is in that country, 00:46:32.200 --> 00:46:34.390 align:middle line:84% there was more capital accumulation per worker, 00:46:34.390 --> 00:46:36.720 align:middle line:90% so k over n went up. 00:46:36.720 --> 00:46:40.260 align:middle line:84% If k over n goes up more in one country than the other one, 00:46:40.260 --> 00:46:44.850 align:middle line:84% y over n will go up more in that country than in the other one. 00:46:44.850 --> 00:46:52.310 align:middle line:84% And the other option is that this function itself shifted up. 00:46:52.310 --> 00:46:56.510 align:middle line:84% So for any given amount of k over n, now 00:46:56.510 --> 00:46:58.340 align:middle line:90% you can produce more y over n. 00:46:58.340 --> 00:47:01.390 align:middle line:84% And that's what we call technological progress. 00:47:01.390 --> 00:47:03.260 align:middle line:90% That's the second thing. 00:47:03.260 --> 00:47:10.520 align:middle line:84% So is the difference in growth of output per person 00:47:10.520 --> 00:47:12.530 align:middle line:84% is due to an increase in k over n, 00:47:12.530 --> 00:47:15.540 align:middle line:84% well, we call that a capital accumulation mechanism. 00:47:15.540 --> 00:47:18.380 align:middle line:84% If it is because the function f shifts up, 00:47:18.380 --> 00:47:20.190 align:middle line:90% that's technological progress. 00:47:20.190 --> 00:47:22.550 align:middle line:84% And what we're going to do is in the next lecture, 00:47:22.550 --> 00:47:24.680 align:middle line:84% we're going to talk about this channel, the capital 00:47:24.680 --> 00:47:26.030 align:middle line:90% accumulation channel. 00:47:26.030 --> 00:47:30.710 align:middle line:84% And in the lecture after the spring break, 00:47:30.710 --> 00:47:34.130 align:middle line:84% we're going to talk about shifts in the function f. 00:47:34.130 --> 00:47:40.370 align:middle line:84% So in figures-- so fixing the technology, 00:47:40.370 --> 00:47:42.470 align:middle line:84% that this is the function f is fixed 00:47:42.470 --> 00:47:45.750 align:middle line:84% and you just move k over n, this is the picture you have. 00:47:45.750 --> 00:47:47.000 align:middle line:90% Now that's a production. 00:47:47.000 --> 00:47:51.530 align:middle line:84% I'm plotting this function here as a function of k 00:47:51.530 --> 00:47:54.970 align:middle line:90% over n for a fixed function f. 00:47:54.970 --> 00:47:56.180 align:middle line:90% And that's what you get. 00:47:56.180 --> 00:47:59.890 align:middle line:84% So output-- I have here capital per worker and output 00:47:59.890 --> 00:48:02.740 align:middle line:90% per worker. 00:48:02.740 --> 00:48:06.343 align:middle line:84% And you see that obviously it's in an increasing function. 00:48:06.343 --> 00:48:09.010 align:middle line:84% The more capital per worker you have, the more output per worker 00:48:09.010 --> 00:48:10.930 align:middle line:90% you produce. 00:48:10.930 --> 00:48:12.240 align:middle line:90% But it's also concave. 00:48:12.240 --> 00:48:14.820 align:middle line:90% 00:48:14.820 --> 00:48:15.570 align:middle line:90% Why is it concave? 00:48:15.570 --> 00:48:20.493 align:middle line:90% 00:48:20.493 --> 00:48:22.035 align:middle line:84% That's decreasing returns to capital. 00:48:22.035 --> 00:48:24.930 align:middle line:90% 00:48:24.930 --> 00:48:28.050 align:middle line:84% When you have very little capital per worker, 00:48:28.050 --> 00:48:30.360 align:middle line:84% a change in capital per worker gives you 00:48:30.360 --> 00:48:33.360 align:middle line:84% a big jump in output per worker because there 00:48:33.360 --> 00:48:34.890 align:middle line:90% was very little capital. 00:48:34.890 --> 00:48:37.620 align:middle line:84% That was a problem with that economy. 00:48:37.620 --> 00:48:40.500 align:middle line:84% When the economy has more and more capital, 00:48:40.500 --> 00:48:44.190 align:middle line:84% the same change in capital leads to a much smaller change 00:48:44.190 --> 00:48:44.700 align:middle line:90% in output. 00:48:44.700 --> 00:48:48.510 align:middle line:84% Here at this level, when capital per worker was very low, 00:48:48.510 --> 00:48:50.310 align:middle line:90% the economy was very poor. 00:48:50.310 --> 00:48:55.410 align:middle line:84% Then this change led to this change in output per capita. 00:48:55.410 --> 00:48:59.010 align:middle line:84% At this level of wealth you get as capital, 00:48:59.010 --> 00:49:02.460 align:middle line:84% economists would hire capital richer, capital per worker, 00:49:02.460 --> 00:49:03.760 align:middle line:90% the same change. 00:49:03.760 --> 00:49:05.640 align:middle line:84% This change is of the same size as that. 00:49:05.640 --> 00:49:08.990 align:middle line:84% Leads to a much smaller change in output. 00:49:08.990 --> 00:49:14.490 align:middle line:84% And that's a result of decreasing returns to capital. 00:49:14.490 --> 00:49:15.730 align:middle line:90% And that's the other option. 00:49:15.730 --> 00:49:17.010 align:middle line:84% Again, that's what we're going to talk about 00:49:17.010 --> 00:49:18.020 align:middle line:90% in the next lecture. 00:49:18.020 --> 00:49:19.710 align:middle line:90% This one. 00:49:19.710 --> 00:49:21.450 align:middle line:84% And two lectures from now, we're going 00:49:21.450 --> 00:49:24.720 align:middle line:84% to talk about growth that comes from shifts in the production 00:49:24.720 --> 00:49:27.060 align:middle line:84% function, this technological progress. 00:49:27.060 --> 00:49:28.490 align:middle line:90% OK. 00:49:28.490 --> 00:49:29.390 align:middle line:90% Very good. 00:49:29.390 --> 00:49:31.540 align:middle line:90% See you on Wednesday. 00:49:31.540 --> 00:49:44.000 align:middle line:90%